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I. Economic environment
(1) Main Economic Developments
- In line with the global economy, Japan's economy has slowed down since its previous Trade Policy Review in 2007 (Table I.1), when real GDP growth was 2.4%. While the economy continued to grow in the firstquarter of 2008, it shrank by an annual rate of 3.0% and 1.8% in the second and third quarters, respectively. Trade plays an important role in the economy; growth in 2007 was led by external demand for Japan's exports and, to a slightly lesser extent, domestic demand, notably household consumption and private non-residential investment.[1] Unemployment in Japan has been on a declining trend, reaching 3.9% in 2007; on a monthly basis, the seasonally adjusted unemployment rate was 4.0% in September 2008, after reaching a low of 3.6% in July2007.[2] Downward pressure on prices remained in 2007 as the year-on-year rate of change in the core consumer price index (CPI excluding fresh food) in the year was the same as in 2006 despite a marked rise in energy prices; this pressure appeared to have eased as monthly core-CPI continued to increase between March and August 2008. In October, however, core inflation slowed for the second straight month to 1.9%, largely due to falling energy prices. Whether this heralds a return to deflation in the near future remains to be seen.
Table I.1
Selected macroeconomic indicators, 2002-08
(¥ trillion and per cent)
/ 2002 / 2003 / 2004 / 2005 / 2006 / 2007 / 2008 /(% change, unless otherwise indicated)
National accounts
Real GDP / 0.3 / 1.4 / 2.7 / 1.9 / 2.0 / 2.4 / -1.8a
Real domestic demand / -0.4 / 0.8 / 1.9 / 1.7 / 1.2 / 1.3 / -1.0a
Private consumption / 1.1 / 0.4 / 1.6 / 1.3 / 1.5 / 1.3 / 1.2a
Government consumption / 2.4 / 2.3 / 1.9 / 1.6 / 0.4 / 2.0 / -1.3a
Gross fixed investment / -4.9 / -0.5 / 1.4 / 3.1 / 0.5 / 1.1 / -3.3a
Real exports of goods and services / 7.5 / 9.2 / 13.9 / 7.0 / 9.7 / 8.4 / 3.4a
Real imports of goods and services / 0.9 / 3.9 / 8.1 / 5.8 / 4.2 / 1.5 / 9.6a
Exports of goods and services (% of GDP) / 10.9 / 11.8 / 13.1 / 13.7 / 14.7 / 15.6 / ..
Imports of goods and services (% of GDP) / 9.6 / 9.9 / 10.4 / 10.8 / 11.0 / 10.9 / ..
Employment / -1.3 / -0.2 / 0.2 / 0.4 / 0.4 / 0.5 / ..
Unemployment rate (annual average) / 5.4 / 5.3 / 4.7 / 4.4 / 4.1 / 3.9 / ..
Household disposable income (% change) / -0.2 / -1.6 / 0.8 / 0.9 / 1.0 / .. / ..
Prices and interest rates
Consumer prices (CPI) (% change) / -0.9 / -0.3 / 0.0 / -0.3 / 0.3 / 0.0 / 2.2b
GDP deflator (% change) / -1.5 / -1.6 / -1.1 / -1.2 / -0.9 / -0.7 / -1.6c
Basic discount rate and basic loan rate (%) / 0.1 / 0.1 / 0.1 / 0.1 / 0.4 / 0.75 / 0.3d
Money stocke (average amount outstanding, % change)
M2 + CDs / 3.3 / 1.7 / 1.9 / 1.9 / 1.1 / 1.6 / 1.7f
Exchange rate (annual average, ¥ per US$) / 125.3 / 115.9 / 108.2 / 110.2 / 116.3 / 117.8 / 97.0d
Table I.1 (cont'd)
(Per cent of GDP)
Fiscal balanceg
Revenue / 30.8 / 30.5 / 30.9 / 31.7 / 34.6 / 33.4 / 35.0
Expenditure / 38.8 / 38.4 / 37.0 / 38.4 / 36.0 / 35.8 / 36.4
Balance / -8.0 / -7.9 / -6.2 / -6.7 / -1.4 / -2.4 / -1.4
Balance excluding social security / -7.9 / -8.0 / -6.6 / -7.0 / -1.4 / -2.2 / -1.2
Government debth / 152.3 / 158.0 / 165.5 / 175.3 / 171.9 / 170.6 / 173.0
Saving and investment
National saving (gross) / 25.1 / 25.3 / 25.7 / 26.7 / 26.5 / .. / ..
Domestic investment (gross) / 23.1 / 22.8 / 23.0 / 23.6 / 24.0 / .. / ..
(¥ trillion, unless otherwise indicated)
Current account balance
Current account / 14.1 / 15.8 / 18.6 / 18.3 / 19.8 / 24.8 / 10.4i
Current account (% of GDP)j / 2.9 / 3.2 / 3.7 / 3.7 / 3.9 / 4.8 / 4.1k
Goods balance / 11.6 / 12.0 / 13.9 / 10.3 / 9.5 / 12.3 / 3.7i
Services balance / -5.1 / -3.6 / -3.7 / -2.6 / -2.1 / -2.5 / -1.1i
Income balance / 8.3 / 8.3 / 9.3 / 11.4 / 13.7 / 16.3 / 8.5i
Net transfer balance / -0.6 / -0.9 / -0.9 / -0.8 / -1.2 / -1.4 / -0.7i
Capital and financial account balance / -8.5 / 7.7 / 1.7 / -14.0 / -12.5 / -22.5 / -11.5i
Financial account / -8.1 / 8.2 / 2.3 / -13.5 / -11.9 / -22.1 / -11.3i
Capital account / -0.4 / -0.5 / -0.5 / -0.5 / -0.6 / -0.5 / -0.2i
Changes in reserve assets / -5.8 / -21.5 / -17.3 / -2.5 / -3.7 / -4.3 / -1.6i
Statistical discrepancy / 0.1 / -2.0 / -3.1 / -1.8 / -3.7 / 2.0 / 2.7i
.. Not available.
a Third quarter, annual rate.
b Figures for July-September 2008.
c Third quarter, % change from the previous year.
d 19 December 2008.
e Money stock here is measured by M2, which includes cash currency in circulation, deposit money (demand deposits), quasi-money (time deposits, etc.), plus CDs, which are certificate of deposit accounts.
f November 2008, % change from November 2007.
g General Government basis. OECD (2008), Economic Outlook, Volume 1, No. 84, Paris. The General Government comprises the central government, local governments, and social security.
h Gross financial liabilities, including the debt of the Japan Railway Settlement Corporation and the National Forest Special Account from 1998 onwards.
i January to June 2008.
j OECD (2008), Economic Outlook, Volume 1, No. 84, Paris.
k January to June 2008. Calculations by the Japanese authorities.
Source: Information provided by the Japanese authorities.
- Economy-wide labour productivity in Japan lags behind that of other major industrialized countries: for example, it is about 30% lower than in the United States.[3] Data provided by the authorities indicate that labour productivity in non-manufacturing is stagnant compared with manufacturing; they attribute this to lower total factor productivity (TFP) growth in nonmanufacturing.[4] Agriculture accounts for a small share of GDP (1.5% in 2006) and employment (5.1% in 2006) (TableI.2). The share of services in GDP decreased slightly in 2006 to 68.8% (from 69.6% in 2005) reflecting mainly decreases in construction, financial services, and wholesale and retail trade; by contrast, services' share in total employment increased from 70.2% in 2005 to 70.3% in 2006. The share of manufacturing in GDP declined slightly from 21.5% in 2005 to 21.3% in 2006, while it's share in total employment rose slightly from 17.2% in 2005 to 17.4% in 2006. Despite lagging labour productivity, Japan's export competitiveness has apparently improved, as reflected in a continuing decline in unit labour costs[5], owing to sluggish wages.
Table I.2
Shares of GDP and employment by sector, 2003-06
/ 2003 / 2004 / 2005 / 2006 /Share of GDP (per cent)
Agriculture, forestry and fishing / 1.7 / 1.6 / 1.5 / 1.5
Mining / 0.1 / 0.1 / 0.1 / 0.1
Manufacturing / 21 / 21.2 / 21.5 / 21.3
Services / 70.2 / 69.5 / 69.6 / 68.8
Construction / 6.6 / 6.6 / 6.4 / 6.3
Electricity, gas and water / 2.6 / 2.6 / 2.4 / 2.2
Wholesale and retail trade / 13.5 / 13.6 / 13.8 / 13.5
Financial services and insurance / 7.0 / 6.8 / 7.0 / 6.9
Real estate / 12.2 / 12.0 / 12 / 11.9
Transport and communications / 7.0 / 6.9 / 6.7 / 6.6
Other services / 21.3 / 21.1 / 21.5 / 21.4
Government / 9.5 / 9.4 / 9.4 / 9.3
Non-profit services for households / 1.9 / 2.0 / 2.0 / 2.1
Import tax and other / 0.8 / 0.9 / 1.0 / 1.1
Statistical discrepancy / 0.6 / 1.0 / 0.4 / 1.3
Total (¥ trillion) / 490.3 / 498.3 / 501.7 / 508.9
Share of employment (per cent)
Agriculture, forestry, and fishing / 5.4 / 5.3 / 5.2 / 5.1
Mining / 0.1 / 0.1 / 0.1 / 0.1
Manufacturing / 17.8 / 17.4 / 17.2 / 17.4
Services / 69.2 / 69.8 / 70.2 / 70.3
Construction / 9.3 / 9.0 / 8.8 / 8.6
Electricity, gas, and water / 0.7 / 0.7 / 0.7 / 0.7
Wholesale and retail trade / 17.2 / 17.0 / 16.9 / 16.7
Financial services and insurance / 2.8 / 2.7 / 2.7 / 2.7
Real estate / 1.5 / 1.5 / 1.5 / 1.5
Transport and communications / 5.8 / 5.8 / 5.6 / 5.8
Other services / 31.9 / 33.1 / 34.0 / 34.3
Government / 5.6 / 5.6 / 5.5 / 5.4
Producers of private non-profit services to households / 1.9 / 1.9 / 1.9 / 1.9
Total (¥ million) / 63.5 / 63.7 / 63.9 / 64.2
Source: Cabinet Office statistics. Viewed at: http://www.esri.cao.go.jp/en/sna/h18-kaku/20annual-report-e.html.
3. Trade and trade-related policies continue to be integral to Japan's ongoing structural reform, particularly as trade plays an increasingly important role in the economy. The shares of exports and imports of goods and services were around 16% and 11% of GDP, respectively, in 2007 (15% and 11%, respectively, in 2006). The faster growth in exports than in imports in recent years reflects the positive contribution of external demand to Japan's economic growth. China overtook the European Communities (EC25) to become the second largest purchaser of Japanese products in 2007, after the United States. China and the United States were the main sources of Japan's imports in 2007. Although Japan's FDI inflows increased significantly in 2007, the level of inward FDI remains low compared with other developed economies. FDI outflows increased steadily between 2005-07.
4. As regards the external sector, Japan's current account surplus increased in 2007; this reflects a widening of the gap between gross national saving and gross domestic investment. The increasing current account surplus in 2007 was due to an increase in the income from foreign bonds (debt) as well as the rising trade surplus. The services account deficit increased from ¥2.1 trillion in 2006 to ¥2.5 trillion in 2007, against the background of increased payments for transportation and other business services. By the end of August 2008, Japan's foreign exchange reserves had risen to US$997billion (up from US$879 billion in August 2006), which is equivalent to about 21 months of Japan's imports. Japan's capital and financial account deficit (outflows) has continued to increase, reaching ¥22.5 trillion in 2007 (up from ¥12.5 trillion in FY2006). Increased outward FDI and a decrease in transactions of Japanese stocks are mainly responsible for the net outflows.
5. Since March 2006, the Bank of Japan (BOJ) has continued its policy to "encourage" (e.g. by means of open market operations) the short-term call rate to remain at around a specified rate; the rate was lowered to 0.3% (from 0.5% previously) on 31October 2008, and to 0.1% on 19December2008. The previous target was 0.25% (from July 2006). The fiscal deficit amounted to around 3.4% of GDP in FY2007 (2.9% in FY2006); and public debt continued to increase, reaching about 170% of GDP. Furthermore, in the supplementary budget for FY2008, the Government allocated ¥1.81 trillion for "Comprehensive Immediate Policy Package".[6] These measures included funding for, interalia, vitalizing SME, supporting local governments, strengthening of agriculture, forestry and fisheries, and for housing and disaster measures; in addition, a fixed-term tax reduction amounting to ¥2 trillion and tax deduction for mortgages were also announced. The Government's mid-term target for fiscal consolidation, as announced in July 2006, is, inter alia, to achieve a surplus in the central and local governments combined primary balance by FY2011, and thus to ensure gradual reduction of the ratio of public debt to GDP between the early and mid 2010s.[7]
6. The Government has continued to place emphasis on structural reforms, and is aware of the need to increase competition and thereby raise productivity, especially in non-manufacturing. However, the pace of reforms has apparently slowed down, and has varied among sectors; it would appear that the Government's recent priority areas include agriculture, medical and nursing services, and air transport.[8]
(2) Macroeconomic Policies
(i) Monetary and exchange rate policy
7. The BOJ ended its "quantitative easing policy" (QEP)[9] in March 2006, and instead started targeting the uncollateralized overnight call rate. On 14 July 2006, the BOJ decided to stop keeping the uncollateralized overnight call rate at "effectively zero per cent" and instead "encouraged" (e.g. by means of open market operations) the rate to remain at around 0.25%. Subsequently, on 21February2007, it "encouraged" the rate to remain at around 0.5%; on 31 October 2008, the BOJ lowered the encouraged rate to around 0.3% and on 19 December 2008 to around 0.1%. The "basic discount rate and basic loan rate" (previously referred to as the "official discount rate") was raised in July 2006 from 0.1% to 0.4%, and again in February 2007 to 0.75%; the rate was lowered to 0.5% on 31 October 2008 and to 0.3% on 19 December 2008.[10] The authorities maintain that the reason for raising this rate was to restore the effective function of the money markets. As the BOJ's monetary policy stopped targeting current account balances of financial institutions held at the BOJ, these declined significantly, from over ¥31trillion in March 2006 to about ¥10.2 trillion at end June2008.[11]
8. The new monetary policy framework is also based on the "assessment" of prices and economic activity from medium-term (one to three years) and long-term perspectives with a view to increasing transparency.[12] Under the new monetary policy framework, BOJ board members consider medium- to long-term price stability to be in the region of zero and 2%. However, this range is not an inflation target or an inflation objective as it is not binding. The BOJ reviews the range annually.
9. The nominal exchange rate of the yen against the U.S. dollar depreciated between January2006 and the end of June 2007 (from ¥115 per U.S. dollar to ¥122). However, since June2007, the yen has appreciated to about ¥97 per U.S. dollar (end October 2008) partly due to the unwinding of the yen "carry trade" (i.e. investors borrowing in yen with low interest and investing in a foreign market, where higher yields are expected).